Citi’s municipal bond strategists lowered their estimates for total muni debt issuance this year in the latest sign that rising rates are deterring local issuers from accessing the market.

At the beginning of the year, the Citi strategists, led by George Friedlander, estimated $400 billion of muni issuance for 2013. As benchmark Treasury yields began climbing in May, dragging municipal bond yields higher as well, the strategists cut their estimates to $375 billion, and then $350 billion. Now the volume estimate has been lowered again — to $320 billion.

The projection includes both “new money”, a term that refers to newly initiated borrowing by a municipality, as well as “refundings”, which replace old debt with new debt to take advantage of lower rates. The latter has fallen off in recent months as cities and states find less of a bargain in refunding. Friedlander writes in a Monday note:

“The key factor in this additional cut is that the latest spike in yields is making a significant portion of potential refunding volume unprofitable –both in current refundings and the more costly “near-current” refunding category. During the first half of the year, new money issuance and refunding issuance came in almost identical amounts, out of first-half supply of $176 billion. July gave a hint of what might be in store for the second half. New money issuance was actually up significantly at $15.6 billion, a 15% increase from last year. However, refunding issuance was off by almost exactly 50%, putting total issuance for the month at roughly minus 12.5%.”

Yields have gone up across the bond market as concerns mount about when the Federal Reserve will scale back its pace of bond purchases. But munis have had to contend with a second burden: the Detroit bankruptcy filing, which has scared off some retail investors and exacerbated bond-fund outflows. The 10-year AAA MMD scale, a benchmark index for muni yields, rose to 2.71% this week, from 1.69% on April 30.

But the loss for municipal borrowers could be a gain for investors, with munis finding a lot of crossover buyers who are looking to take advantage of attractive yields.

“The back-up in muni rates make munis incredibly attractive,” said Dan Heckman, fixed-income strategist at U.S. Bank Wealth Management, in an interview. He added that dwindling muni issuance may mean demand outstrips supply in the remainder of the year, setting the market up for a rebound.

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